My name is Johanna Reiter-Brüggemann, I’m a member of the EWOR Academy and I specialise in international trade law, compliance, and white-collar crime. Today, I would like to invite you to reflect about CSR and ESG from a legal perspective. Please note that this article is written from an European point of view. In other jurisdictions, CSR and ESG may be less prominent or raise different questions.
Businesses all over the world, including start-up companies, benefit from global price differences and the international division of labour. This so-called vertical specialisation provides both opportunities and risks for stakeholders in international value and supply chains.
There are numerous examples of the adverse impact of international trade and business on human rights or the environment. In order to illustrate this, we only have to look at the 2012 factory fire at Ali Enterprises in Pakistan, which caused 259 deaths due to barred emergency exits, or the forced labour and other human rights violations caused by the mining of conflict minerals and other raw materials (tin, tungsten, tantalum and gold – 3TG, cobalt, lithium), or recent reports about the forced labour of Uyghurs in China’s Xinjiang province.
Firstly, I would like to set out the regulatory background, and in a second step, explain why even early-stage start-ups should take ESG seriously.
From soft law to hard law
As founder and/or CEO, your first and foremost responsibility is of course to your start-up and its shareholders. Nevertheless, over the past few years, national, European, and international business standards have emerged, outlining a responsibility that goes much further and marks the change from “shareholder primacy” to a “broader stakeholder capitalism” (Harvard Business Review, 10 ESG Questions Companies Need to Answer).
Initially, public and even private regulatory initiatives set voluntary standards, known as soft law, proposing to companies to implement an ESG due diligence (including ESG risk assessment and management). Examples of such non-binding standards are the United Nation’s Guiding Principles on Business and Human Rights of 2011 and the OECD Guidelines for multinational enterprises.
Studies, however, have shown that only a few companies implemented these voluntary soft-law proposals. Against this background, national legislators and the European Union decided to create binding standards such as the following (non-exhaustive list!):
- the French Loi relative au devoir de vigilance of 2017,
- the German Sorgfaltspflichtengesetz (entering into force in 01/2023),
- the Dutch Wet zorgplicht kinderarbeid (entering into force mid 2022)
- the European Unions Regulation (EU) 2017/821 introducing a supply chain due diligence for EU importers of conflict minerals.
There is more regulation on the horizon: after a long wait and many delays, on the 23rd of February 2022, the European Commission published its proposal for a Directive on Corporate Sustainability Due Diligence.
In light of this changing regulatory landscape, start-ups and established businesses alike should as a first step identify all current and planned legal ESG instruments (including sector-specific provisions) applicable in their relevant jurisdictions. (Note that the examples referred to above are not exhaustive!).
The results will show that for SMEs, ESG due diligence is rarely mandatory. For example, the German Act on Corporate Due Diligence in Supply Chains will only apply to companies with more than 3,000 employees as of January 2023 and to companies with more than 1,000 employees as of January 2024.
What is not provided for by law might be required by contract
Start-ups working at a B2B level might have to implement ESG due diligence due to contractual obligations. In B2B relationships, customers are often bigger companies that are or will be bound by mandatory ESG law. To ensure their own compliance, they typically impose clauses asking suppliers to also comply with ESG standards. Check out the American Bar Association’s Model Contract Clauses to Protect Workers in International Supply Chains, Version 2.0.
At the moment, many companies only ask their suppliers for declarations of intent. This will likely change once they themselves are bound by mandatory law (in Germany as of 2023 or 2024, depending on the size of the company).
The Importance of ESG Data for Funding
Investment Funds and Private Equity investors regularly ask for and monitor ESG data and ratings of their portfolio companies. Angel investors and VC funds do so less frequently. Even impact investors often focus more on the impact created by the start-up’s products and less on ESG risk management. But early-stage investors are likely to increasingly ask for ESG risks once more and more potential acquirers will be bound by ESG regulation.
Compliance with ESG Standards might help you in case of litigation
Even though early-stage start-ups are usually too small to fall under the scope of mandatory ESG regulation, compliance with ESG standards can help to minimize litigation risks. This becomes more and more important. To give some examples:
- In May 2021, The Hague District Court held in a landmark case that Shell’s climate goals did not suffice to meet the company’s obligation to act against climate change.
- In the German Danzer case, German authorities had to decide whether to bring criminal charges against a German-based manager of Danzer Group who was accused of having failed to prevent human rights abuses (including rape and murder) by hired security forces in the Democratic Republic of Congo. The public prosecutor eventually decided not to bring criminal charges based on procedural considerations unrelated to the question of whether the manager in question could in fact be held liable for negligence.
- In France, public prosecutors have opened proceedings against four textile companies accused of having tolerated forced labour in their supply chains.
For SMEs that are not bound by mandatory ESG regulation, the cases cited above are interesting for two reasons:
1) They show that ESG litigation and criminal charges are brought even if ESG risk management is “voluntary”.
2) Proper ESG due diligence could have either prevented the alleged violations and the litigation in its entirety, or would at least have been a powerful defence.
Finding the right balance with ESG
As a start-up, you have one great advantage: you are building your venture from scratch. This means while your established competitors have great difficulties tracing all their existing, often obscure supply chains and checking them for risks, you can start with transparent, ESG-compliant value chains, communicate that you do so and thus add value to your start-up. Soon, this will be a great advantage for you and your business, allowing you to win new customers and recruit talent to whom ESG matters.
ESG is an ongoing process. Start simple, educate yourself and your staff (especially those in procurement) and get professional legal help where you need it.
If you are based in Germany – start here to gain basic knowledge on the subject.